Florida Bar Journal

South Dakota v. Wayfair: The Case That Changes Everything

Have you ever bought something on the internet? Did the seller charge you tax? If not, have you ever wondered why?

Many online retailers have not been charging tax to their customers because of a U.S. Supreme Court case from 1992, Quill Corp. v. North Dakota, 504 U.S. 298 (1992). In Quill, the Court held that states could not compel a company to collect or remit tax on its sales to state residents unless the company has “physical presence” within that state.

In the decades following Quill, online retailers have been able to sell products to customers at a “no tax discount” relative to traditional brick-and-mortar stores. This market imbalance became a huge issue with the growth of internet commerce, which has put state governments in a bind. Normally, residents of a state are still required to pay tax even when the online retailer does not collect it. In practice, state departments of revenue are unwilling or unable to audit millions of individual residents for potentially unpaid sales or use tax. This is especially true in Florida, where the absence of a state income tax means that Florida residents do not normally file any state tax returns.^[1]

States have been left to audit businesses that are often surprised they had to pay tax on their online purchases. Meanwhile, the unpaid taxes on purchases by individuals were left uncollected.^[2] Though state governments have never been happy about this situation, until recently they were not actively doing much to change things other than lobbying Congress. The approach of the states changed in 2015, when U.S. Supreme Court Justice Anthony Kennedy invited states to take “another run” at Quill. The result of these state efforts led to the Court’s recent decision in South Dakota v. Wayfair, Inc., 585 U.S. ___, 138 S. Ct. 2080 (2018).

The Wayfair decision overruled Quill and eliminated the “physical presence” test. Now, every state in the union can potentially force online retailers to collect and remit sales tax on their sales into those states. This new dynamic will color the entire field of sales and use taxation for decades to come.

The Way Things Used to Be

In order to comprehend how much things could change under Wayfair, we must examine why the world of online sales tax has evolved in the way it has. The starting point for the analysis is Quill, the Supreme Court’s 1992 decision on “remote seller” tax liability.^[3]

The Quill case involved an office equipment and supply company, Quill Corp., that solicited business through catalogs, flyers, advertisements in national periodicals, and telephone calls. One of the states that it solicited business in was North Dakota, a state where Quill Corp. had at least 3,000 customers. None of Quill Corp.’s employees or facilities were located in North Dakota. All of its merchandise was delivered to North Dakota customers via mail or common carrier from locations outside of the state.^[4]

Quill Corp. took the position that North Dakota did not have the power to compel it to collect a use tax on goods that it sold to its North Dakota customers. The Tax Commissioner of North Dakota filed suit in state court to compel Quill Corp. to collect use taxes on its North Dakota sales. The North Dakota Supreme Court departed from prior U.S. Supreme Court precedent to hold that Quill Corp. was obligated to collect and remit use tax to the state. The U.S. Supreme Court reversed, holding that Quill Corp. lacked sufficient “nexus,” or connection, with North Dakota to allow the state to compel Quill Corp. to collect taxes on its sales to North Dakota residents.^[5]

The Quill decision created two distinct nexus tests based on the U.S. Constitution’s due process clause and commerce clause, respectively. These tests were intended to help courts decide whether a state has a close enough connection to a remote seller to allow it to impose taxes on its sales. A state had to “pass” both nexus tests under Quill in order to constitutionally impose tax on transactions between state residents and remote sellers.^[6]

The due process nexus test under Quill has survived the Wayfair decision and remains applicable. This test is a “flexible” standard that is not dependent on a seller’s physical presence within a state. Instead, a remote seller can meet the due process nexus requirement through “purposeful direction” of its efforts toward a state to solicit business. The flexibility of this standard reflects the purpose of the due process clause, which is primarily about “the fundamental fairness of government activity.” The relevant question is, therefore, whether the remote seller has purposefully availed itself of the economic market in the forum state. Under Quill, a remote seller is unlikely to win a challenge to a state statute based on the due process nexus requirement. A remote seller that avails itself of a state’s economic market to any significant degree will satisfy the due process nexus requirement.^[7]

The commerce clause nexus test created under Quill did not survive Wayfair. This test was a bright-line test that required a seller to have a physical presence in a state before the state could impose a duty to collect use taxes.^[8] Though Quill itself addressed a company engaged in mail-order sales, its holding applied to internet retailers as well: Unless a vendor had a physical presence in a given state, that state could not require the vendor to collect sales or use taxes on a sale to a resident of that state. This “physical presence” test was what the Court disposed of in Wayfair.

Quill Was a Safe Harbor

The physical presence test created by Quill meant that if a company did not have physical presence within a state, that state could not, as a matter of constitutional law, force that company to collect and remit sales and use tax. In this way, physical presence served as a “safe harbor” for retailers. They could build their businesses around the certainty that if they did not have physical presence within a state, they would not have any tax collection responsibilities in that state.

The safe harbor of physical presence was only one part of the analysis, though. If a company had some physical presence in a state, the question always existed as to how much of a presence was enough to create “substantial nexus” sufficient to allow the state to impose tax collection and remittance duties on the taxpayer. The taxpayer could always argue that its particular example of physical presence was not enough of a presence to rise to the level of substantial nexus required by the commerce clause.

An example of this is found in the case of Florida Department of Revenue v. Share International, Inc., 676 So. 2d 1362 (Fla. 1996), which involved a Texas company in the business of selling chiropractic supplies. The company had no offices in Florida and no employees or agents residing in the state. The company sold products to Florida residents through direct mail solicitation.^[9]

Representatives of the company were present in Florida at an annual trade show for several days a year. The First District Court of Appeal held that the presence of the company’s representatives satisfied the “physical presence” rule under Quill. However, this only meant that the company’s activities were not within the “safe harbor” provided by the Quill bright-line test. The First District held that even though the company was not protected from Florida taxation, the presence of the company’s representatives at the trade show was not enough to satisfy the “substantial nexus” requirement of the commerce clause. Therefore, the state of Florida could not impose tax on the company’s mail-order sales into the state. The Florida Supreme Court affirmed the decision.^[10]

The Share case shows that even when physical presence existed, it was important to analyze whether that physical presence was substantial enough to satisfy the commerce clause. With the safe harbor of Quill eliminated by Wayfair, this “substantiality analysis” takes on increased importance. Even companies without physical presence in a state may find themselves arguing about whether their nonphysical contacts with state residents have created “substantial nexus” under the commerce clause.

This represents a sea change in the law of state taxation. Before grappling with some potential consequences of this change, it is worth examining how the Wayfair case came before the Court, and what problem the Court thought it was solving by eliminating Quill’s safe harbor. The short, strange trip of Wayfair provides a map for how broadly (or not) one should read the decision.

Direct Marketing v. Brohl: Kennedy’s Invitation to Chaos

Internet commerce became a huge part of our economy in the years following Quill. The physical presence safe harbor for remote sellers allowed internet retailers to effectively undercut brick-and-mortar retailers by not charging sales tax. When such companies were located outside of the state they were shipping into, Quill stood as an absolute bar to that state’s enforcement of any sales and use tax collection or remittance responsibility.

Amazon and other online retailers who were immune to state tax collection obligations grew conspicuously large at the same time that our nation went into an extended recession. Though state tax collections dropped for a myriad of reasons, the rapid rise of “tax-free” internet sales became an easy target for the complaints of cash-strapped state governments. This dynamic led states to engage in a variety of creative attempts to “get around” the physical presence safe harbor afforded by Quill. These initiatives, often dubbed “Amazon laws,” involved ways of imputing physical presence to sellers that would otherwise fall into the safe harbor of Quill.^[11]

The state of Colorado experimented with a unique Amazon law that was meant to sidestep the physical presence question completely. Instead of trying to directly impose a tax collection and remittance responsibility on remote sellers through a creative definition of “physical presence,” Colorado created a reporting requirement for such sellers. When a remote seller got beyond a certain level of sales, the remote seller had to provide the state with a list of customers and sale amounts. The idea was that the state could use this list to collect the presumably unpaid sales and use taxes directly from state residents.^[12] The Colorado “reporting law” generated a significant amount of litigation, resulting in a U.S. Supreme Court decision in 2015. Though many in the tax community expected the Court to address Quill in its decision, the Court restricted its holding to the application of the Tax Injunction Act to the case before it.^[13]

Though the majority in Direct Mktg. Ass’n v. Brohl, 575 U.S. __, 135 S. Ct. 1124, 1128 (2015), punted on the question of Quill, Justice Kennedy addressed the issue in his concurring opinion. He called for a case to be brought before the Court that would allow Quill to be overturned once and for all. His words are worth quoting: “Given [the] changes in technology and consumer sophistication, it is unwise to delay any longer a reconsideration of the Court’s holding in Quill…. The legal system should find an appropriate case for this Court to reexamine Quill and Bellas Hess.”^[14] In other words, Brohl was not the right case for the Court to revisit Quill, but as soon as the right case came before the Court, Quill would be overturned if Kennedy had his way.

Kennedy’s concurrence was read (correctly, it appears) as a call for states to deliberately violate Quill, take the case to court, lose at the lower court level, and then appeal to the U.S. Supreme Court to overturn its precedent. Several states took Justice Kennedy up on his invitation and passed “anti-Quill” statutes after 2015.^[15]

States Behaving Badly

South Dakota was one of a number of states that enacted laws designed to directly violate the Quill physical presence test. Alabama enacted a regulation to take effect on January 1, 2016, requiring businesses with in-state sales over $250,000 to collect sales tax and remit it to the state.^[16] Tennessee enacted a similar rule with a $500,000 sales threshold.^[17] Other states, beginning with Minnesota, targeted online marketplaces, requiring the marketplaces (especially those with locations in state) to collect taxes from remote-seller users with over $10,000 in sales into the state.^[18] Washington and Rhode Island combined Colorado’s notice and reporting requirements with Minnesota’s focus on online marketplaces, requiring marketplaces to report.^[19]

South Dakota’s challenge to Quill came in the form of legislation amending its laws to require out-of-state businesses without a physical presence in the state to pay sales tax to South Dakota if they either generated gross revenue surpassing $100,000 from sales into the state or made at least 200 sales into the state.^[20] The governor signed this legislation into law in March 2016.^[21] The South Dakota legislation signaled an intent to overturn Quill as quickly as possible:

Given the urgent need for the Supreme Court of the United States to reconsider [the Quill] doctrine, it is necessary for this state to pass this law clarifying its immediate intent to require collection of sales taxes by remote sellers, and permitting the most expeditious possible review of the constitutionality of this law.^[22]

Wyoming and Indiana took the South Dakota bill as a model for their own “Anti-Quill” laws to the point of using the same $100,000 and 200 transaction amounts.^[23] Like South Dakota’s bill, Wyoming’s remote sales tax statute was “designed to directly challenge the ruling in Quill.”^[24] South Dakota and Wyoming were ready to litigate right away. South Dakota’s law “provided for expedited court consideration of the state’s potential challenge to Quill,” putting litigation “on a fast-track schedule, with the express understanding that South Dakota [would] seek U.S. Supreme Court review.”^[25] In April 2016, South Dakota used its newly enacted law to sue major online retailers Wayfair, Systemax, Overstock.com, and Newegg in state court.^[26]

The ensuing litigation led to a decision by the South Dakota Supreme Court holding that because “Quill remains the controlling precedent on the issue of Commerce Clause limitations on interstate collection of sales and use taxes” until the U.S. Supreme Court abrogates it, the South Dakota Supreme Court affirmed the summary judgment.^[27] In January 2018, the U.S. Supreme Court agreed to hear the case.^[28]

Wayfair and What Happens Next

If you’ve read this far, you know how the story ends: South Dakota won the case, as the U.S. Supreme Court overturned Quill and removed the physical presence safe harbor for remote sellers. The question now is what happens next?

The full scope of Wayfair’s consequences will only become clear as cases are litigated in the post-Quill world. With the caveat that no one can fully predict the future, the authors offer the following observations on what this new world might look like.

• 50-State Problems — Under Quill, a retailer selling products online could be fairly certain about when it faced a tax collection and remittance responsibility. If the sale was to be shipped to a customer in the retailer’s state, sales tax was most likely due. Now, the same retailer faces a new problem: Every sale delivered to a state that charges sales tax might create a tax collection and remittance responsibility for that retailer. For the first time, small retailers may face compliance costs and audit risks in all 50 states.^[29]

• No More Bright Lines: Everything is Gray — Though the Quill physical-presence test was criticized for years as an arbitrary standard, the test at least drew a bright line that was easily understood by taxpayers and state governments. Now the bright line is gone. It has been replaced by ambiguity as to what “substantial nexus” means. The Court’s decision in Wayfair can be read to have “blessed” the South Dakota approach of defining substantial nexus in terms of 200 transactions or $100,000 in sales per year. However, the Court did not say anything about whether this is a minimum standard for substantial nexus or not. What of a state with a 100 transaction threshold? 50 transactions? Is that enough for substantial nexus? If so, why? If not, why not? Businesses will have to grapple with these kinds of questions whenever they sell products online.^[30]

• Florida’s Mail Order Statute is Alive and Well — Florida’s statute on “mail order sales,” F.S. §212.0596, was enacted in 1987 specifically to assert the state’s jurisdiction over remote sellers. In creating this law, the legislature found that remote sellers “are morally obligated to assume their fair share of the burden of maintaining this state’s prosperity and quality of life by collecting and remitting taxes on sales to [Florida customers].”^[31]

As written, §212.0596 creates a tax collection and remittance responsibility on remote sellers without physical presence in Florida when, among other things: the property sold was delivered after a Florida resident ordered the property while in Florida; the remote seller “purposefully or systematically” exploited the Florida market through direct mail or advertising, including “computer-assisted shopping”; the remote seller is subject to the jurisdiction of another state that uses its taxing power in support of Florida’s taxing power; or the remote seller is subject to service of process under F.S. §48.181.^[32]

Though the statute casts a broad net upon remote sellers, the state has been constrained in enforcing its terms due to the physical presence safe harbor under Quill. With this safe harbor gone, §212.0596 is constrained only by the question of whether a particular remote seller has “substantial nexus” with Florida under its unique facts. How far this gets pushed will depend on whether the legislature clarifies what “substantial nexus” means under §212.0596 and the post-Wayfair policies adopted by the Department of Revenue.

• Impacts on Other Taxes? — While Quill and Wayfair both addressed sales and use taxes, the “substantial nexus” analysis under the commerce clause addresses a state’s power to impose a tax generally — it is not limited to sales and use tax. This means that for other taxes levied by the state of Florida (apart from corporate income tax), the Quill safe harbor formerly applied in the same way that it applied to sales and use tax.^[33]

With the abolition of the Quill safe harbor, other taxes may apply to companies doing business in Florida without a physical presence. The most significant tax that comes to mind is the Communications Services Tax. The CST applies to sales of communications services to Florida residents.^[34]

An example of a court applying the commerce clause analysis to CST is found in Florida Department of Revenue v. DIRECTV, Inc., 215 So. 3d 46 (Fla. 2017). Though “substantial nexus” was not deeply discussed in DIRECTV (as the “discrimination” prong of the test was at issue), the case illustrates the fact that the same commerce clause test addressed in Quill and Wayfair applies beyond the sales and use tax context.^[35] Because the commerce clause test applies to CST generally, Wayfair implies that a provider of communications services may be subject to CST in Florida even if the provider has no physical presence in Florida at all. This dynamic can be extrapolated to other taxes the state currently has the power to impose or which the legislature creates in the future. A lack of physical presence in Florida is no longer a safe harbor for companies that provide taxable goods or services to Floridians.^[36]

• Retroactive Application? — The Wayfair decision left the door open for states to retroactively apply its holding to remote sellers who, in reliance on Quill, did not collect or remit sales and use taxes in states where they had no physical presence. The Court noted that the South Dakota statute at issue expressly stated that it would not apply retroactively should the Court overturn Quill. Though this was stated with approval, the Court in no way held that the lack of retroactivity in South Dakota was key to its holding.^[37]

Tax professionals are openly discussing the possibility of some states taking the position that Wayfair applies retroactively. This would mean that state governments could assess taxes against remote sellers that failed to collect and remit sales and use taxes because of Quill. Whether states take this position or not is ultimately a political question.^[38]

Conclusion

The Wayfair decision has changed decades of precedent in the world of sales and use tax jurisprudence. Its ramifications will likely echo for decades to come.

This column is submitted on behalf of the Tax Law Section, Michael D. Minton, chair, and Benjamin A. Jablow, Christine Concepcion, and Charlotte Erdman, editors.